Tài liệu OECD Economic Surveys CANADA 2012 pdf

OECD Economic Surveys
CANADA
JUNE 2012
OVERVIEW

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any territory, to the delimitation of international frontiers and boundaries and to the name of any
territory, city or area.
The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli
authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights,
East Jerusalem and Israeli settlements in the West Bank under the terms of international law
.




© OECD 2012 1
Summary
The economy withstood the global economic crisis thanks to a timely
macroeconomic policy response and a solid banking sector. Although strong profits in
the mining and oil sectors have supported business investment, employment growth
slowed in the autumn and winter, and confidence weakened, largely reflecting temporary
factors. The latest indicators suggest the economy is picking up, and the outlook is for
continued moderate output growth and inflation in 2012-13. However, record low mortgage
rates have pushed house prices up substantially in some cities, and boosted household
indebtedness, which poses an increasing risk.
Monetary policy remains appropriately accommodative given persistent global
headwinds and associated risks and the withdrawal of fiscal stimulus, but it should
stand ready to react to signs of a pickup in inflation. Price pressures are evident in
housing and sectors related to mineral extraction, while core inflation is running at about

2%. To moderate growth in house prices, macro-prudential measures such as stricter
standards for government-backed mortgage insurance have been implemented and may
have to go further. The 2012 federal budget features significant public spending cuts
designed to achieve budget balance by 2015-16. Even larger efforts are being made in some
provincial budgets, notably Ontario’s. This tightening is necessary to reduce the debt
overhang resulting from the past recession and stimulus measures, but the authorities
should slow the pace of consolidation if significant downside risks to growth materialise.
Boosting innovation can raise historically weak productivity growth to sustain
living standards. Indeed, innovation is high on the government’s agenda. While Canada
has made great strides in macroeconomic and structural policy settings, and its academic
research is world class, the pay-off in terms of business innovation and productivity growth
has not been large. Business R&D is particularly low, despite significant policy support,
suggesting substantial scope for improvement. Competitive pressures, which spur
innovation, have recently intensified because of the high exchange rate, but further market
opening in sheltered sectors like network industries and professional services would be
beneficial. Reforms are needed to improve knowledge flows to business and strengthen the
process of commercialisation. Government support to R&D should focus more on
sharpening incentives and raising performance; the higher current tax subsidy rate for
small domestic firms should be unified at the lower large firm rate to encourage firms to
attain the scale needed to adopt innovations. Savings could be used to keep capital costs in
the eligible base to avoid creating distortions across different technologies.
Improvements in tertiary education will also be critical to support socially inclusive
growth in a knowledge-driven economy. While the tertiary system generally performs
well, generating high attainment among the working-age population, participation at the
tertiary level will need to continue growing to maintain the supply of highly skilled labour
as the population ages. Further improving equity of access by reducing non-financial
barriers and increasing targeted need-based financial assistance – funded by reduced
education tax credits where public finances are constrained – and by fostering a more
flexible system that facilitates lifelong learning along a diverse range of student pathways is
a priority. Efforts should be increased to recruit foreign tertiary students and integrate them

into the workforce upon graduation. Universities make strong contributions to research, but
teaching relies increasingly on large class sizes and sessional lecturers. Governments
should consider greater differentiation across institutions as regards research versus
teaching. Greater integration of technical, business, communications and industry training
within tertiary programmes could contribute to innovation and improving graduate skills.


© OECD 2012 2
Assessment and recommendations
Overview
Canada weathered the global economic crisis well, mainly reflecting sustained growth
in domestic pending, and the economy is continuing to grow despite the persistence of
international turbulence, most recently stemming from the euro zone sovereign debt crisis.
In Canada’s case, several factors are acting in its favour. Federal fiscal plans are seen by
markets as credible, favouring low borrowing costs. The banking system is sound and
required no taxpayer bailouts during the 2008-09 crisis. Comparatively strong growth
among emerging market economies has shifted global purchasing power to commodity
exporters like Canada
via
both higher export prices and stronger currencies. Nevertheless,
uncertainty regarding the global situation and risk-averse financial markets are a drag on
business confidence and investment, while prolonged low interest rates could push
mortgage-debt and house prices higher from already elevated levels, at least in some large
cities.
Canada enjoys strong institutions and policy credibility, but for many years its
economic growth has relied mainly on increasing labour and capital inputs. By contrast,
growth of multi-factor productivity (MFP) has been weak and declined further in the past
decade. Innovation indicators such as business R&D and patenting rates are poor. Boosting
innovation is an important and well established way of raising MFP growth, which is in turn
needed to sustain rising living standards, especially as the population ages.

The overarching theme of this
Survey
is improving the policy framework for innovation,
including in particular by strengthening the role of the tertiary education sector. Chapter 1
considers how to raise business innovation and concludes that increased service-sector
competition and better design of public support, including less reliance on tax credits,
would help. Chapter 2 considers policies to expand the supply of highly skilled workers and
enhance the performance of Canada’s many tertiary education institutions to better meet
the economy’s skill needs for innovation and growth.
Macroeconomic developments
The Canadian economy recovered from the 2008-09 global economic crisis relatively
quickly thanks to timely monetary and fiscal stimulus, a sound financial system and high
commodity prices (Figure 1, Panel B). Unemployment has fallen substantially since the
recession peak and is now near its long-term average rate as well as OECD estimates of its
structural rate (Panel C), and real business investment and corporate profit margins have
been restored to pre-crisis levels. The economic expansion experienced a soft patch in
late 2011 and again early in 2012, largely reflecting temporary factors. Employment
stagnated from summer 2011 for about six months, with particular weakness in the public
sector (Panel D), unemployment crept up, and heightened uncertainty in global financial
markets surrounding the European sovereign debt crisis eroded confidence (Panel E). But
high frequency indicators and fairly easy business credit conditions point to somewhat
stronger economic growth going forward.


© OECD 2012 3
Figure 1. Economic indicators
2000 2002 2004 2006 2008 2010
-10
-5
0

5
10
15
20
A.Real GDP growth (Q-on-Q annualised, %)
Total domestic demand contribution to GDP growth
Foreign balance contribution to GDP growth
GDP growth
2000 2002 2004 2006 2008 2010
5.5
6.0
6.5
7.0
7.5
8.0
8.5
9.0
C. Unemployment rate (%)
2000 2002 2004 2006 2008 2010
75
80
85
90
95
100
105
D. Employment levels
Index, October 2008 = 100
Total
Private sector

Public sector
2000 2002 2004 2006 2008 2010
3500
4000
4500
5000
5500
6000
6500
H. Household net worth
Billions CAD
2000 2002 2004 2006 2008 2010
60
65
70
75
80
85
90
95
100
105
-20
0
20
40
60
80
E. Consumer and business confidence
Consumer confidence index

Business confidence ¹
2000 2002 2004 2006 2008 2010
0.9
1.0
1.1
1.2
1.3
1.4
1.5
1.6
1.7
0.7
0.8
0.9
1.0
1.1
1.2
1.3
1.4
1.5
F. Exchange rate and export performance
CAD per USD
Export market performance ²
2000 2002 2004 2006 2008 2010
0
20
40
60
80
100

120
50
100
150
200
250
(index, 2005 = 100)
B. Oil prices and non-oil commodity prices
Oil prices, USD per barrel
Non-oil commodity prices
2000 2002 2004 2006 2008 2010
-1
0
1
2
3
4
5
6
G. Inflation
Year-on-year percentage change
Consumer price index
Core inflation

1. Measured as the percentage of firms expecting higher future sales growth over the next 12 months minus the
percentage expecting less, from the Bank of Canada's Business Outlook Survey.
2. Ratio of export volumes to the size of export markets (defined as the trade-weighted average of trading partners'
imports).
Source
: Thomson Reuters; OECD, OECD

Economic Outlook 91
database; OECD calculations.


© OECD 2012 4
Merchandise exports to the United States have recovered about 75% of their decline
since the 2008 peak, and those to emerging market economies have far surpassed their
pre-crisis levels (Figure 2). Moreover, robust growth in emerging market economies has
propelled a large part of the surge in demand for Canadian commodity exports over the
past decade. Goods sold to non-OECD countries now account for almost 10% of the total
value of merchandise exports, up from 5% in 2000, whereas the US share has shrunk from
about 84% to 72% over the same period. The Canadian dollar has appreciated significantly
in the past 10 years and remains strong both against the US dollar and on a trade-weighted
basis. This appears to be largely explained by sharp increases in commodity prices,
especially for energy (Cayen
et al.
, 2010). The appreciation has contributed to a worsening of
the current account balance from a surplus of around 2% of GDP in the early 2000s to a
deficit of near 3% of GDP in recent years.
Figure 2. Merchandise exports by region
Millions CAD
2008 2009 2010 2011
0
20000
40000
60000
80000
100000
120000
0

2000
4000
6000
8000
10000
12000
14000
16000
Exports to USA
Exports to EU
Exports to non-OECD

Source
: Statistics Canada.
The economy continues to undergo structural adjustments due to these persistent
relative price movements since the early 2000s. The export-oriented manufacturing sector
had by 2011 shrunk sharply to only 12.6% of total value added, down from a peak of 18.6% in
2000. Its share of employment has also fallen substantially over the past decade (from 15.2%
to 10.2%), and somewhat more than in the United States (Figure 3). Both outcomes have
been clearly correlated with exchange-rate developments. Regional growth disparities –
based on a real disposable income per capita measure – mirror these divergences in
sectoral activity: the resource-rich provinces of Alberta, Saskatchewan, and Newfoundland
and Labrador have enjoyed the largest per capita income gains during the past decade
(Figure 4), whereas growth has been more sluggish in the manufacturing centre of Ontario.
Much of Alberta’s strength has been attributable to population increases due to
employment opportunities. Alberta remains the most affluent province, thanks to its energy
wealth. Strong prices for energy and other primary commodities are likely to persist, given
the gradual recovery in world growth and continuing turmoil in the Middle East.

© OECD 2012 5
Figure 3. The share of manufacturing in the Canadian economy is heavily influenced
by the exchange rate
Canada
versus
the United States
1985 1990 1995 2000 2005 2010
11
12
13
14
15
16
17
18
19
20
0.9
1.0
1.1
1.2
1.3
1.4
1.5
1.6
1.7
A. As a share of GDP in real terms (%)
Canada (left scale) USA (left scale)
1980 1985 1990 1995 2000 2005 2010
8

10
12
14
16
18
20
22
24
0.9
1.0
1.1
1.2
1.3
1.4
1.5
1.6
1.7
B. As a share of total employment (%)
Exchange rate, CAD per USD (right scale)

Source
: Bureau of Economic Analysis; Bureau of Labor Statistics; Statistics Canada; and OECD calculations.
Figure 4.The shifting pattern of real per capita incomes across the provinces¹
Share of the national average
70
80
90
100
110
120

130
%

70
80
90
100
110
120
130
%

NL PE NS NB QC ON MB SK AB BC
2000
2010

1. Nominal disposable income per capita by province deflated by the consumer price index of each province.
Source
: Statistics Canada.
The short-term outlook is for relatively moderate economic growth at just above
potential rates and a slight upward tilt as external demand becomes increasingly supportive
(Table 1). The fragile US recovery and problems in the euro area, along with the strong
Canadian dollar, will limit export growth, although high commodity prices should continue
to bolster corporate profits in the energy sector, which, together with the low cost of capital,
should support business investment. Planned fiscal consolidation will be beneficial for
market confidence and for longer-term sustainability but could weaken domestic demand.
Household net worth has declined with weak equity prices (Figure 1, Panel H), which is,
along with the moderate pace of job creation and projected tighter lending conditions, likely
to restrain private consumption growth. Nevertheless, private consumption and investment
will continue to be the main drivers of growth.

Although strong gains in world food and energy prices, and the effect of the
introduction of the Harmonized Sales Tax (HST) in Ontario and British Columbia in the third
quarter of 2010, held headline year-on-year inflation near the 3% upper limit of the Bank of
Canada’s target range for much of 2011, inflation expectations have remained anchored at
close to the 2% midpoint. Headline inflation has eased since the end of 2011, while core


© OECD 2012 6
inflation has edged up to around 2%, and the wedge between the two has been eliminated
(Figure 1, Panel G).
Table 1. Short-term projections
Annual percentage change, volume (chained 2002 Canadian dollars)
2008 2009 2010 2011 2012 2013
Demand and output
GDP at market prices 0.7 -2.8 3.2 2.5 2.2 2.6
Private consumption 3.0 0.4 3.3 2.2 2.4 2.9
Government consumption 4.4 3.6 2.4 1.2 0.2 -0.5
Gross fixed capital formation 2.0 -13.0 10.0 6.9 3.9 5.0
Public 8.1 8.6 18.2 -3.0 -7.1 -0.5
Private residential -3.3 -7.8 10.1 2.3 3.7 2.6
Private non-residential 3.7 -20.8 7.3 13.7 7.1 7.2
Stockbuilding
1
-0.2 -0.7 0.6 0.2 -0.3 0.0
Total domestic demand 2.8 -2.8 5.2 3.2 2.0 2.7
Export of goods and services -4.7 -13.8 6.4 4.4 5.2 6.2
Imports of goods and services 1.5 -13.4 13.1 6.5 4.3 6.3
Net exports
1
-2.2 0.0 -2.0 -0.8 0.2 -0.1

Prices and employment
GDP deflato
r
4.1 -1.9 2.9 3.3 2.2 1.8
Consumer price index 2.4 0.3 1.8 2.9 2.3 2.2
Underlying price index 1.7 1.8 1.7 1.7 2.1 2.0
Total employmen
t
1.7 -1.6 1.4 1.5 1.1 1.1
Unemployment rate 6.1 8.3 8.0 7.5 6.9 6.6
Memorandum item
s
:


General government financial balance
2
-0.4 -4.9 -5.6 -4.5 -3.5 -2.4
Cyclically adjusted government primary balance
2
-0.9 -3.0 -4.2 -3.7 -2.9 -2.1
General government gross debt
2
71.2 82.4 84.0 83.8 84.5 81.4
General government net debt
2
22.8 28.5 30.6 33.3 35.3 36.3
Short-term interest rate 3.5 0.8 0.8 1.2 1.3 2.1
Current account balance
2

0.3 -3.0 -3.1 -2.8 -2.4 -2.3
Output gap
(
per cent of potential GDP
)
1.1 -3.1 -1.5 -1.1 -1.0 -0.6
1. Contributions to changes in real GDP (percentage of real GDP in previous year).
2. As a percentage of GDP.
Source
: OECD,
Economic Outlook 91
, May 2012.
Monetary and financial-market policies
A delicate balancing act for monetary policy
To support the economic recovery, the Bank of Canada has appropriately maintained a
highly accommodative stance by keeping its policy rate at 1.0% since September 2010. While
the Bank has indicated that some modest withdrawal of the present monetary stimulus
may become appropriate, the prolonged period of low interest rates raises concerns about
the risks it presents for the financial system. The stance of monetary policy in the quarters
ahead will have to balance the relatively strong cyclical position of the Canadian economy,
compared to the United States and most of Europe, and the income effects of the favourable
terms of trade against the predominance of downside risks to activity in the short term
resulting from fiscal consolidation and the strong dollar. This balance of risks, in a context
of moderate inflation and apparently well anchored inflation expectations, suggests that for
now policy can afford to remain supportive of activity. However, as the year 2012 wears on,
and if the downside risks fail to materialise, consideration will have to be given to
withdrawing more stimulus by raising policy rates. The need for such actions, conditional
on continued reduction in economic slack, will increase as time goes by.

© OECD 2012 7
The inflation-targeting framework has proven effective
At the end of 2011, the Bank of Canada together with the federal government renewed
the inflation-targeting framework for an additional five years, maintaining the target at 2%.
This monetary framework enjoys a high degree of credibility, and inflation has remained
close to the target of 2% since 1995. Among other reasons, the 2010 OECD
Economic Survey
of Canada
had argued that a significant regime shift to price-level targeting could add to
market uncertainties and would thus be undesirable in the context of still rising
government debt and precarious global economic prospects.
Slowing global growth and, more particularly, the European sovereign debt crisis are
additional factors that have amplified risks to financial stability. Though Canadian banks
have little direct exposure to the vulnerable euro area countries, a major shock could have
detrimental indirect effects through lower equity prices and higher funding costs.
Wholesale funding is an important component of bank funding in Canada (about 30%),
though this share has decreased somewhat in recent years (Bank of Canada, 2011). Fears
over credit risk may reduce access to such funding, as occurred during the 2008-09 financial
crisis, and lead to a renewed tightening of credit availability. Such developments could
depress economic activity and generate increasing loan losses in a negative feedback loop.
Long-term interest rates have declined markedly since spring 2011 (Figure 5), which is
putting strains on institutional investors. The solvency of Canadian pension funds has been
pushed towards all-time lows (Bank of Canada, 2011). Life insurance companies, which like
pension funds have fixed liabilities, also suffer from low interest rates. This may result in
imprudent risk-taking behaviour as financial institutions seek to boost investment returns,
although reduced risk appetite in financial markets engendered by uncertainties in the
global economy may act as a mitigating force. Nonetheless, greater vigilance will be needed
to ensure pension reserves are sufficient to counter solvency risks.
Figure 5. Interest rates
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

2010 2011
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Bank of Canada policy rate
Government of Canada benchmark 10-year yield

Source
: Statistics Canada and Bank of Canada.
Housing-related debt presents risks to financial stability
Although Canada’s household indebtedness is close to the OECD average, it is high by
historical standards, making households vulnerable to a possible decline in real estate
prices. Growth in consumer credit has moderated since mid-2010 (Figure 6, Panel C).
However, households have continued to increase borrowing at a faster pace than the rise in
their disposable incomes, as they have done over the last 10 years, reflecting cheap

mortgage rates and appreciating property prices. As a result, household debt has


© OECD 2012 8
accumulated to record levels (Panels D and E). Low interest rates are for now keeping
mortgage debt-servicing affordable for most (Panel B), but the share of indebted households
spending more than 40% of their income on interest payments remains above the 2000-10
average (Bank of Canada, 2011).
Canada experienced a significant increase in house prices in the run-up to the
2008 crisis, but unlike in many countries with a similar experience, notably the
United States, Canadian house prices have continued to rise (Figure 7, Panel B). Residential
investment declined only slightly as a share of output during the global financial crisis and
has since rebounded to close to the pre-recession peak (Figure 7, Panel A) and looks set to
rise further, at least over the short term, given the latest figures on housing starts. Indeed,
the absence of a real estate collapse is an important reason for Canada’s relatively good
economic performance during the crisis. While there are some signs of market imbalances,
they do not appear to be widespread but are concentrated in certain segments of the
market (
i.e
. condominiums) and certain locations (Toronto and Vancouver). In particular,
the stock of unoccupied multiple units has swelled (Figure 7, Panel F), even after accounting
for increases in multiple units in the market.
Residential mortgages, including mortgage securitisations, accounted for about 52% of
Canadian banks’ total domestic-currency loans and asset securitisations at the end of 2011,
up slightly from 48% at the end of 2007, as the former strong uptrend tapered off in recent
years. While bank loan losses and non-performing loans remain low at 0.3% and 2% of the
total stock, respectively, a negative shock to employment or economic growth, or an
increase in interest rates, would impair households’ ability to service their debts (FSB, 2012).
Fortunately, the majority of mortgages are still held on originating banks’ books rather than
securitised, giving them strong incentives to employ sound underwriting standards.

Approximately seventy per cent of the residential mortgage market in Canada is backed
by government guarantees in the case of default. Federally regulated financial institutions
must purchase insurance on all mortgages with a loan-to-value (LTV) ratio above 80%,
either from the Canada Mortgage and Housing Corporation (CMHC, an agency owned by the
federal government) or a private insurer; and 90% of the value of privately insured
mortgages is guaranteed by the federal government. Insuring high-LTV ratio mortgages
through CMHC lowers their capital risk weight on banks’ books from 35% to zero. If
insurance is bought from a private insurer, the risk weight is only slightly higher (5%), given
the 90% government guarantee. Government backing of a large portion of bank assets
helped importantly to maintain the system’s stability during the crisis but also implies that
the public finances may be exposed in the event of a major shock to housing markets.
CMHC operates on a commercial basis with pricing set to generate commercial rates of
return and to cover expected default rates. At the end of 2011, CMHC reported insurance in
force totalling CAD 567 billion (34% of GDP). This makes CMHC one of Canada’s largest
financial institutions. Given its current legislated limit of CAD 600 billion, CMHC indicated
in early 2012 that portfolio (bulk) mortgage insurance for low ratio mortgages
(i.e
. mortgages
with down payments of 20% or higher) was being rationed due to unexpected requests for
large amounts of coverage, a possible sign of perceived risks of substantial price declines by
lenders. According to the government, this rationing should ensure that CMHC continues to
operate within the limit on its mortgage insurance in force without constraining the
availability of high LTV ratio mortgage insurance for qualified homebuyers.


© OECD 2012 9
Figure 6. Credit indicators
2002 2004 2006 2008 2010
-60
-40

-20
0
20
40
60
80
A. Business credit availability ¹
Balance of opinions
Tighter
Easier
Overall lending conditions
Credit availability
2007 2008 2009 2010 2011
3
4
5
6
7
8
B. Effective borrowing cost
Per cent
Effective business interest rate
Effective household interest rate
2002 2004 2006 2008 2010
0
5
10
15
20
C. Credit growth

Year-on-year percentage change
Total business credit
Household credit - residential mortgages
Consumer credit
2000 2002 2004 2006 2008 2010
0.15
0.16
0.17
0.18
0.19
0.20
0.21
D. Household debt to assets ratio
2000 2002 2004 2006 2008 2010
1.0
1.1
1.2
1.3
1.4
1.5
1.6
E. Household debt to disposable income ratio
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5

F. Debt-to-disposable income ratio ²
in OECD countries, 2010
POL
HUN
SVK
ITA
BEL
AUT
DEU
FRA
FIN
ESP
CAN
PRT
GBR
USA
SWE
AUS
NOR
NLD
DNK
Average of available OECD countries

1. Percentage of financial institutions reporting tightened conditions/availability, minus percentage reporting
eased conditions/availability.
2. Household and unincorporated business.
Source
: Panel A : Bank of Canada, Overall lending conditions from Senior Loan Officers Survey and credit availability
from Business Outlook Survey; Other panels: Statistics Canada, Cansim database; Bank of Canada; Thomson Reuters.
CMHC recently reported that almost 90% of the high-LTV borrowers insured had a high

credit score, indicating a strong ability of a great majority of borrowers to manage their
debt. Measures were recently announced as part of the 2012 federal budget to strengthen
the governance and oversight framework of CMHC. Proposed legislative measures include
authority for the Office of the Superintendant of Financial Institutions (OSFI) to review and
monitor the safety and soundness of CMHC’s commercial activities. This change is likely to
bolster the credibility of both CMHC and Canadian prudential regulation.


© OECD 2012 10
Figure 7. Housing indicators
2000 2002 2004 2006 2008 2010
50
100
150
200
250
B. Nominal house prices
Index, 2000 q1 = 100
Canada
United States
United Kingdom
Australia
Ireland
2000 2002 2004 2006 2008 2010
0.24
0.26
0.28
0.30
0.32
0.34

0.36
0.38
0.40
E. Mortgage service ratio and long-term average
Per cent
Long-term average
Mortgage service ratio ³
2000 2002 2004 2006 2008 2010
80
100
120
140
160
C. House price to income ratio ¹
Index, 2000 = 100
Canada
United States
United Kingdom
Australia
Ireland
2000 2002 2004 2006 2008 2010
40
60
80
100
120
140
160
180
D. House price to rent ratio ²

Index, 2000 = 100
Canada
United States
United Kingdom
Australia
Ireland
2000 2002 2004 2006 2008 2010
0
5
10
15
20
F. Housing completions, average unoccupied (%)
Share of total completions by type
Multiples
Singles
2000 2002 2004 2006 2008 2010
0
1
2
3
4
5
6
7
8
A. Residential investment as a share of GDP (%)
Canada
Australia
United Kingdom

United States

1. Nominal house prices divided by nominal disposable income per head.
2. Nominal house prices to rents.
3. The proportion of average personal disposable income per worker that goes towards mortgage payments on a
quarterly basis based on current house prices and mortgage rates.
Source
: Bank of Canada; CMHC,
Housing and Market Information
; Thomson Reuters; OECD, OECD
Economic
Outlook 91
database; OECD calculations.
In recognition of the risks to financial stability posed by the housing sector, between
October 2008 and April 2011 the federal government implemented a series of
macro-prudential measures to tighten regulations of government-backed mortgage
insurance. First, the maximum amortisation period for new mortgages was reduced in
stages from 40 to 30 years. Maximum LTV ratios needed to qualify for government
guarantees were lowered. Government-backed insurance was also withdrawn on home
equity lines of credit, and requirements were imposed on minimum credit scores and loan
documentation. Government-backed insurance also defines minimum qualifying interest
rates which must be used in determining borrower eligibility for all variable rate loans and
fixed rate loans under five years. These changes have helped to moderate household
borrowing and cool the housing market. However, further measures may be needed –


© OECD 2012 11
possibly targeted on certain market segments – if imbalances persist. Indeed, OSFI just
issued draft detailed guidelines for prudent residential mortgage underwriting by all
federally regulated financial institutions.

Reforms to financial supervision are in progress
The Canadian authorities have taken welcome steps to address vulnerabilities in the
financial system, while actively participating in international efforts to strengthen
macro-prudential regulation through the Basel Committee on Banking Supervision of the
BIS and the Financial Stability Board (FSB) of the G20. Canada’s big six banks are expected to
meet the Basel III requirements for a 7% common equity Tier 1 risk-adjusted capital ratio,
including the capital conservation buffer, by 2013 (FSB, 2012). Canada will also implement a
countercyclical capital buffer as required. Other measures include the expansion of OSFI
resources for supervision and on-site inspections and implementation of regular
system-wide joint stress testing by OSFI and the Bank of Canada. Accountability has been
improved through revisions to the intervention and resolution regime, with recovery plans
for the big six banks expected to be finalised in 2012. Implementation of Basel III
requirements for minimum loss absorbency in Tier 1 capital should ensure banks fully
absorb losses before taxpayers. Progress has also been made in restructuring asset-backed
commercial paper and structured finance markets – which were severely impaired during
the crisis – to enhance transparency and disclosure. Furthermore, regulation has been
drafted to strengthen internal controls on credit rating agencies, which include procedures
to identify conflicts of interest and prohibit the issuance of ratings where such conflicts
exist.
In securities markets, the federal government has made substantial efforts to create a
single national securities regulator, consistent with recommendations made in the
2010 OECD
Economic Survey of Canada
. Progress was halted at the end of 2011, however,
when the Supreme Court determined that the proposed legislation was not constitutionally
valid under the general branch of the federal power to regulate trade and commerce. The
Court also indicated that “[t]he common ground that emerges is that each level of
government has jurisdiction over some aspects of the regulation of securities and each can
work in collaboration with the other to carry out its responsibilities”. It recognised that
federal jurisdiction could include the management of systemic risk and ensuring fair and

efficient national capital markets. The federal government has since indicated that it is
consulting with provinces and territories, and that a number of them have reaffirmed their
interest in working on a cooperative basis towards establishing a common securities
regulator. Moving in this direction would generate efficiency gains and improve the
attractiveness of listing in Canada, as it would lead to a reduction in duplication and
unnecessary regulatory burdens on market participants. Indeed, the ¨passport system¨,
adopted by all provinces except Ontario, has provided savings by allowing market
participants to use one principal regulator for approval in all jurisdictions. However, the
current structure of securities regulation remains fragmented and may imply gaps in the
co-ordination of policy development and enforcement across borders, as noted by the
FSB (2012).
Fiscal policies to support strong and inclusive long-term growth
The economic downturn and resulting injection of stimulus (worth about 4% of GDP at
the federal level) drove up gross and net government debt levels significantly. The general
government balance deteriorated from a surplus of 1.4 % of GDP in 2007 to a deficit of 4.5%
of GDP in 2011 (Table 1). As a result, general government gross debt expanded by about
20 percentage points of GDP to reach 85% of GDP by the end of 2011. Some of this rise was
related to a non-budgetary transaction: the issuance of new federal debt to finance the
acquisition of government-backed mortgage insurance bonds from the CMHC under the
Insured Mortgage Purchase Program; progressive liquidation of these assets will, conversely,
act to reduce the gross debt by CAD 2.4, 41.9 and 10.6 billion in 2012-13, 2013-14 and
2014-15, respectively. While the gross debt-to-GDP ratio is projected to fall to around three


© OECD 2012 12
quarters of the OECD average, net debt as a share of GDP may remain a little more than half
of the OECD average by 2013 (Figure 8). This reflects the existence of relatively large general
government financial assets: as at end 2011, the federal government held assets amounting
to 15% of GDP; provincial and local governments; 35% of GDP; and the Canada/Quebec
Pension Plan, 11% of GDP. Over 40% of total government financial asset holdings were

claims largely in the form of equity and loans to commercial Crown corporations
(
e.g
. CMHC, Farm Credit Canada and Business Development Bank of Canada).
Figure 8. Net government debt as per cent of GDP
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
0
10
20
30
40
50
60
70
80
90
0
10
20
30
40
50
60
70
80
90
Projections
Canada
G7 average
OECD average

Source
: OECD,
OECD

Economic Outlook 91
database.
Federal fiscal consolidation is underway
The federal government has begun to eliminate its deficit and expects to return to a
balanced budget or better by 2015-16, based on reasonable economic assumptions (growth
averaging 2.3% per year) and protected by CAD 3 billion in annual downward revenue
adjustments to account for negative risks (Table 2). The result is that its projection for the
federal net debt-to-GDP ratio peaks at 33.9% in 2012-13 and then falls by some
six percentage points in the following four fiscal years. The speed of this consolidation is
reasonable unless serious downside risks to growth materialise. If they do, Canada’s low
indebtedness and well earned reputation for fiscal probity allow it room to respond by
slowing the pace of consolidation as needed.
The deficit-elimination strategy outlined in the 2012 budget continues to rely largely on
spending cuts (some 82% of the cumulative savings of CAD 58.6 billion over seven years in
the three latest budgets), without raising tax rates or cutting transfers to individuals or
other levels of government. This involves curbing direct programme spending from 7.3% of GDP
in 2010-11 to 5.5% in 2016-17, through near-zero increases in real terms for the five-year planning
period) including unwinding stimulus measures. Departmental budgets will be cut by a total of
some CAD 21 billion in the next five years culminating in CAD 5.2 billion in 2015-16. This
represents 1.9% of total programme spending and will reduce federal employment by 19 200
(about 4.8% of the total, compared to 14.4% realised in the 1990s downsizing episode). The budget
also proposed raising the retirement age to 65 for new federal employees as of 2013 and boosting
the employee share of pension contributions to 50%.
Revenues are expected to rise by around 4.7% per year, only slightly faster than GDP.
Part of the increase is cyclical, and part results from the semi-automatic increase in

employers’ and employees’ Employment Insurance contribution rates that is required to
balance that account following the recession-induced deficit incurred in recent years, even


© OECD 2012 13
though the government decided to slow the uptrend in such rates (at a budgetary cost of
CAD 2.6 billion over five years).
Table 2. The 2012 federal budget outlook
CAD billions
2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17
Budgetary revenues 237.1 248.0 255.0 270.4 285.5 300.0 312.5
Per cent change -2.1 1.0 1.4 1.7 1.8 3.1 2.6
Per cent of GDP 14.6 14.4 14.3 14.6 14.7 14.8 14.8
Total expenditures 270.5 272.9 276.1 280.6 286.9 296.6 304.7
Per cent change -1.3 0.9 1.2 1.6 2.2 3.4 2.7
Per cent of GDP 16.7 15.9 15.5 15.1 14.8 14.6 14.4
of whic
h
:
Major transfers to persons 68.1 68.5 72.2 75.5 78.1 81.0 84.0
Major transfers to other
levels of government
53.0 56.9 58.4 60.3 62.8 65.6 68.5
Direct programme expenses 118.5 116.5 114.7 113.7 113.0 115.1 116.1
of whic
h
:
Operating expenses 77.2 77.6 76.8 76.5 76.7 79.2 80.0
Public debt charges 30.9 31.0 30.8 31.1 33.0 34.9 36.1
Budgetary balance -33.4 -24.9 -21.1 -10.2 -1.3 3.4 7.8

Per cent of GDP -2.1 -1.4 -1.2 -0.5 -0.1 0.2 0.4
Federal debt
1
550.3 581.3 602.4 612.5 613.9 610.4 602.6
Per cent of GDP 33.9 33.8 33.9 33.0 31.6 30.1 28.5
1. This measure of debt is the federal government’s accumulated deficit, which is a measure of its net worth, as
it includes the value of federal non-financial as well as financial assets.
Source
: Government of Canada, Budget 2012 and Finance Canada updates.
The focus on achieving consolidation largely on the spending side is appropriate.
Studies have shown that fiscal consolidation tends to be more effective when expenditure
restraint is used rather than measures to raise government revenues (Guichard
et al
., 2007).
Nevertheless, care will need to be taken to ensure that adequate social supports remain in
place for vulnerable segments of society. At the aggregate level, the Gini coefficient suggests
that market income inequality rose from the mid-1990s to the early 2000s and has remained
relatively unchanged since then. While these inequalities are partially offset through the
redistributive role of the tax and benefit system, OECD (2011c) finds that this effect has
declined through time with roughly one-quarter of market income inequality being offset
by redistribution, down from about one-third in the mid-1990s (Figure 9). And relative to its
OECD counterparts, Canada’s tax and benefit system is less redistributive. This is mainly
due to the reduced role of means-tested benefits and transfers, and an increased emphasis
on in-work incentives, rather than changes to the income tax system. The result is that
after-tax, after-transfer income has become much more unequal, with, for example, the top
1% accounting for 10% of all income in 2007, up from only 6 to 7% up to the mid-1990s.
Nevertheless, the share of Canadians living below the nation’s low-income cut-off has
fallen sharply, such that basic needs are being met for most.
Eliminating untargeted and ineffective tax expenditures should be considered as a way
to expand fiscal space at both federal and provincial levels, while improving the efficiency

and fairness of the tax system, as recommended in the chapter on taxation in the
2008
OECD Economic Survey of Canada
. The federal government reports over 150 tax
expenditure items, though its definition of what constitutes a tax expenditure is quite
broad. These include beneficial tax credits for pension savings plans and the like, but also
measures which tend to benefit wealthier households, such as the deduction for employee
stock options, and favoured investors, such as flow-through shares for mining firms. The


© OECD 2012 14
2012 federal budget seeks to make a few changes in this vein that would save
approximately CAD 2 billion in the next five years, primarily on the corporate side.
Figure 9. Share of market-based income inequality offset by the tax and transfer system
in OECD countries
0
10
20
30
40
50
60
%

0
10
20
30
40
50

60
%

MEX
CHL
KOR
TUR
ICE
USA
ISR
CHE
CAN
NZL
AUS
JPN
GRC
NLD
EST
ESP
OECD
PRT
GBR
POL
ITA
SLK
NOR
SWE
FRA
LUX
DNK

DEU
HUN
CZE
SLV
FIN
AUT
BEL
Latest data
Mid-1990s

1. Difference between pre- and post-tax and transfer Gini coefficients as a share of the pre-tax and transfer Gini
coefficient for the entire population in per cent.
Source
: OECD.stat, Income distribution database.
Promoting longer-term sustainability and inclusive growth
Long-term demographic trends imply lower per capita GDP growth and increased
spending pressure for health care, social services and income support for the elderly. The
first pillar of the pension system – Old Age Security (OAS) and the Guaranteed Income
Supplement (GIS) – is not likely to pose as significant a fiscal problem as in some other
OECD countries, but spending, at 4½ per cent of GDP, is nevertheless projected to rise in the
coming decades to 6¼ per cent of GDP (Whitehouse, 2010). The rationale behind the federal
government’s decision in the recent budget to programme a gradual rise in the eligibility
age for OAS and GIS benefits to 67 between 2023 and 2029 was to ensure that social
programmes remain sustainable over the long term and reflect demographic realities. The
policy change also introduced the option to defer take-up of the OAS pension for up to five
years and receive a higher, actuarially adjusted, pension. This option will be available
starting in July 2013, and the adjusted pension will be calculated on an actuarially neutral
basis. It is clear that Canadians are being encouraged to work longer and save more
themselves for their retirement.
Provincial governments face a more difficult task. Some face large structural deficits

and still rising net debt to GDP ratios that will require resolute reforms to overcome
(Table 3). While most intend to balance their budgets over the next several years, relying
entirely on spending control, concerns over the Ontario government’s debt levels prompted
a downward revision to the outlook for its credit rating at the end of 2011. Given lacklustre
growth prospects, the government-appointed Commission on the Reform of Ontario’s Public
Services (2012) reported that maintaining current fiscal policies could drive net debt to 51%
of provincial GDP by 2017-18. It went on to identify 362 potential savings.
The Ontario government responded to the report in its 2012 budget with CAD 22 billion
in deficit reduction over the next three years, about 80% of which would be achieved
through spending restraint. Much of that will rely on wage freezes for civil servants, doctors
and teachers, along with delaying the planned cut in corporate tax, freezing social
assistance rates and slowing the rate of investment. The deficit – 2.4% of provincial GDP in
2011-12 – will be eliminated only in 2017-18 (and even that relies on spending increases


© OECD 2012 15
being held below 1% per year in the final two years of the planning horizon), but Ontario’s
net debt is expected to peak at 41.6% of its GDP in 2014-15 before falling back.
Table 3. Aggregate provincial and territorial fiscal indicators
2012 budget estimates
(Provincial public accounts basis)
Actual Forecast
2010-11 2011-12 2012-13 2013-14 2014-15
Biillions CAD
Revenue 299 310 320 334 349
of whic
h
:
Total own-source revenue 231 244 254 n.a. n.a.
Federal transfers 68 66 65 n.a. n.a.

Expenditure 322 332 339 345 352
Other factors 2 -1 -1 -1 -1
Surplus/Deficit
(
-
)
1
-21 -23 -19 -12 -4
Net deb
t
435 480 517 504 521
Per cent of GDP
Total own-source revenue 14.2 14.2 13.9 N.A. N.A.
Federal transfers 4.2 3.9 3.6 N.A. N.A.
Total revenue 18.4 18.0 17.6 17.6 17.6
Total expenditure 19.8 19.3 18.7 18.2 17.7
Surplus/Deficit
(
-
)
1
-1.3 -1.3 -1.1 -0.6 -0.2
Net deb
t
26.8 27.9 28.5 n.a. n.a.
Memorandum items:

GDP
(
billions CAD

)
2
1 625 1 719 1 818 1 899 1 985
Annual per cent change
2
5.8 5.7 4.4 4.5
1. Surplus/deficit is not equal to revenue minus expenditure because of small other factors not
reported in the table.
2. Average private sector forecast surveyed by the Department of Finance Canada for 2012 budget.
Source
: Finance Canada and OECD calculations.
Provinces also face substantial longer-term challenges because they are responsible for
health spending, which already accounts for a sizeable share of provincial output (Figure 10)
and nearly half of provincial government spending. Containing these costs in the years
ahead will not be easy. The federal government recently announced plans to continue its
payments to provinces for health care – the Canada Health Transfer (CHT) – past the expiry
date of current legislation on 31 March 2014 (Box 1). From 2014-15 to 2016-17, the CHT will
continue to grow at its current rate of 6% annually. However, this pace could not have been
sustained in the longer term. Hence, beginning in 2017-18, the CHT will rise in line with a
three-year moving average of nominal GDP growth, with a minimum guaranteed increase of
3% annually. The Parliamentary Budget Office (PBO) estimates that the new formula could
reduce the federal share of provincial and territorial health spending from 20.4% in 2010-11
to an average of 13.8% over the 25-year period starting in 2036 under a scenario where
average health care spending growth (at more than 5% per year) is assumed to outpace
nominal GDP increases over the period (Matier, 2012).


© OECD 2012 16
Figure 10. Health-care expense indicators
1000

2000
3000
4000
5000
6000
7000
8000
A. Public health expenditure per capita
1997 CAD
CAN NL PE NS NB QC ON MB SK AB BC YT NWT NV
♦
♦
♦
♦
♦
♦
♦
♦
♦
♦
♦
♦
♦
♦
♦
2011¹
1999
2009
0
5

10
15
20
25
B. Public health expenditure as share of GDP
Per cent
CAN NL PE NS NB QC ON MB SK AB BC YT NWT NV
1999
2009
0
5
10
15
20
25
30
0
5
10
15
20
25
30
C. Population 65 years of age and over
Percentage of total
CAN NL PE NS NB QC ON MB SK AB BC YT NWT NV
2010
2025

1. CIHI projections.

Source
: CIHI (2011),
National Health Expenditure Trends, 1975 to 2011
and Statistics Canada.
Box 1. Federal government’s major transfers to provinces and territories
The federal government provides financial support to provincial and territorial
governments primarily through four transfer programmes: the Canada Health Transfer (CHT),
the Canada Social Transfer (CST), the Equalization Program and the Territorial Formula
Financing (TFF). In 2012-13, these transfers amount to CAD 59 billion or 24 per cent of the
federal government’s total programme spending.
Canada Health Transfer
The CHT is the largest federal transfer programme to provinces and territories. The CHT is
composed of an equal per capita cash and tax point transfer. Provinces and territories must
fulfil the conditions stipulated in the Canada Health Act to receive the full federal CHT cash
contribution.
In 2007, the federal government amended the legislation such that the cash transfer
component of the CHT be distributed on an equal per capita basis starting in 2014-15. In the
2012 budget, the federal government confirmed that it will provide protection such that no
jurisdiction receives less than its 2013-14 CHT cash allocation in subsequent years as a result of
the move to equal per capita cash transfers.
In December 2011, the federal government announced that the CHT will continue to grow
at 6% annually until 2016-17. Starting in 2017-18, the CHT will grow in line with a three-year
moving average of nominal GDP growth, with funding guaranteed to increase by at least 3% per
year.
Canada Social Transfer
The CST is a federal block transfer to provinces and territories in support of tertiary
education, programmes for children and other social programmes. These funds are transferred


© OECD 2012 17

on an equal per capita basis, and provincial and territorial governments have the responsibility
to design and deliver programmes, and are accountable to their citizens and legislatures for
outcomes achieved and dollars spent. In order to receive their full contribution under the CST,
provinces and territories must not impose minimum residency requirements for receiving
social assistance.
Total CST levels are legislated to grow by 3% annually until 2013-14. In December 2011, the
federal government announced that the CST will continue to grow at its current rate in 2014-15
and beyond.
Equalization Program
The Equalization Program addresses fiscal disparities across provinces. Equalization
payments allow less prosperous provincial governments to provide their residents with public
services that are reasonably comparable to those provided in other provinces at reasonably
comparable levels of taxation.
Equalization entitlements are determined by measuring a province’s ability to raise
revenues if it were to impose national average tax rates (commonly referred to as fiscal
capacity). Before any adjustments, a province's per capita Equalization entitlement is equal to
the amount by which its fiscal capacity is below the average fiscal capacity of all provinces
(known as the 10-province standard). In order to provide provinces with a net fiscal benefit
from their natural resources, the calculation does not fully take their revenues from this source
into account but limits this benefit to ensure fairness among provinces. The Equalization
formula ensures that the transfer grows consistently with a three-year moving average of
nominal GDP growth.
Territorial Formula Financing
The Territorial Formula Financing (TFF) programme enables the three territorial
governments to provide a range of public programmes and services to their residents that are
comparable to those offered by provincial governments with comparable levels of taxation. TFF
is based on the difference between a proxy of the territory's expenditure requirements (known
as the Gross Expenditure Base) and the territory's capacity to raise its own revenues.

The move to a transparent, stable and ultimately less generous formula for the CHT

hardens the budget constraint for provincial and territorial governments. They will have to
respond by slowing health-care outlays: Ontario, for example, is aiming to limit its annual
average health-care expense growth to 2.1% between 2011-12 and 2014-15, about a third of
the ten-year historical average. At the same time, greater budget predictability enhances
provincial and territorial governments’ ability to manage and invest in their health-care
systems, while respecting the
Canada Health Act
as the sole condition for receipt of the
CHT. Provincial and territorial governments are required to uphold the five principles of the
Canada Health Act
: universality, comprehensiveness, portability, accessibility and public
administration, as well as provisions relating to prohibiting extra billing and user charges
Planned changes to the CHT are also likely to widen regional inequalities. Currently, the
CHT is allocated to provinces based on population and includes both cash and tax point
transfers. The inclusion of corporate and personal income tax point transfers from the
federal government to provincial and territorial governments in 1977 provided an implicit
interprovincial redistributive element. The 2007 budget announced that, starting from 2014,
the CHT will be allocated to provinces based on population through a cash transfer
exclusively. Since per-capita health spending is on average six times higher for Canadians
over the age 65 than for others this favours provinces with younger populations, at the
expense of those which are ageing more quickly, such as British Columbia, Québec and the
Atlantic provinces (Figure 10, Panel C). The federal equalisation system is designed to deal
with regional disparities directly or indirectly, and the pressures due to widening
health-care cost disparities may eventually require this system to be enriched.


© OECD 2012 18
Strengthening the fiscal framework through well designed and transparent fiscal rules
can help achieve consolidation goals and long-term sustainability at all levels of
government, as discussed in OECD (2010a). Establishing a target debt-GDP ratio would

anchor fiscal policy in the long term and help to prevent divergences over time (25% had
been adopted in 2004). Multi-year indicative budgeting would increase transparency and
improve planning, and a spending ceiling would provide a transparent mechanism to
enforce the fiscal path. The PBO could be usefully charged with evaluating budgets and
budget outcomes relative to the path chosen by the government.
Box 2. Recommendations for macroeconomic and financial policies
Priority recommendations:
• Maintain the current level of interest rates for the time being in light of good
inflation outcomes and significant downside risks to the global economy. Tightening
may well become necessary late this year, so long as downside risks do not
materialise by then.
• Continue to closely monitor developments and risks in housing markets and
household debt. If imbalances continue to widen, the government should respond
with further tightening of macro-prudential measures.
• Implement fiscal consolidation plans as budgeted, but slow the pace of tightening
should economic prospects weaken significantly. Implement the rise in the pension
age as planned. Continue with federal and provincial structural spending reforms,
particularly in health care and in provinces with large structural deficits, to move
towards long-term fiscal sustainability. Eliminate inefficient tax expenditures,
especially those that are regressive, such as those for stock options.
Other recommendations:
• Strengthen the fiscal framework by adopting a long-term debt ratio target with
associated multi-year budgeting and spending ceilings.
• Improve securities market regulation by implementing as comprehensive a
securities regulator as possible, consistent with the Supreme Court decision.

Canada’s key long-term challenge is to boost productivity growth
Over the past few decades, multifactor productivity (MFP) in Canada has been stagnant,
and it has even fallen since 2002 (Figure 11). Per capita income growth has nevertheless
held up thanks to increasing factor utilisation and, since 2003, robust terms-of-trade gains.

Regarding the former, and reflecting earlier tax and benefit reforms, female participation
has risen strongly, and the share of the population working is now 4 percentage points
higher in Canada than in the United States. Capital intensity is also slightly higher in
Canada, although it is heavily weighted toward engineering structures to the detriment of
machinery and equipment, particularly, in the form of information and communication
technologies (ICT). The composition of output can also affect measured productivity, but
weak productivity appears to be spread widely across sectors and therefore controlling for
composition still leaves most of the puzzle to be explained (Chapter 1).
MFP is a “black box” residual, but as an empirical matter it captures the main sources of
rising living standards over the long term. There is some evidence that it is the product of
investments in human capital and innovation (Jones, 2002; Jaumotte and Pain, 2005;
Hall
et al
, 2010). Indeed, MFP growth is sometimes used as a direct measure of innovation
(National Economic Council, 2011). Canada’s expert panel on business innovation concluded
that the long-term average growth of MFP is the best comprehensive indicator of
innovation, the latter defined to include advances arising from not only science and


© OECD 2012 19
technology (R&D), but also improvements in business models and processes of all kinds
(CCA, 2009). Intensified innovation should, therefore, boost MFP growth.
Figure 11. Productivity in Canada relative to the United States
Total economy
1970 1980 1990 2000 2010
80
90
100
110
120

130
A. Economic performance of Canada relative
to the United States
Index 1998 = 100
Hourly labour productivity
Real gross domestic product per capita
Real gross national income per capita
1990 1995 2000 2005 2010
11000
12000
13000
14000
15000
16000
17000
18000
B. Multi-factor productivity
USD constant prices, constant PPP’s
Canada
United States

Source:
Centre for the Study of Living Standards (2011),
Aggregate Income and Productivity Trends, Canada vs.
United States – www.csls.ca/data/ipt1.asp
; calculations from Johansson, A.
et al.
(2012), “Long-term growth scenarios”,
OECD Economics Department Working Paper
, forthcoming; OECD

Annual National Accounts database.
Fostering business innovation
Innovation is an exceedingly complex, lengthy and risky process. It can be promoted by
multiple enabling factors in the broader economy and society itself. Efficient resource
allocation, characterised by the fluid entry and growth of innovative firms and exit of less
productive ones, magnifies the benefits of innovation (OECD, 2012a). Canada possesses
many of these assets, notably macroeconomic stability, a good regulatory framework and a
well educated workforce. However, disadvantages include uneven (though relatively low)
capital taxation, limited capital markets for funding innovation, insufficiently strong
competitive pressures in certain sectors, and weak “connective tissue” that links research to
commercialisation. Also, with relatively abundant labour and low relative labour costs, at
least until recently, Canadian firms have been under less pressure to innovate than firms in
other countries. One result is very low business R&D (BERD) by OECD standards (Figure 12).
Government policies in support of R&D investment and regarding aspects of tertiary
education should be re-examined, particularly in light of weak commercialisation of ideas.
Taxation is becoming more competitive internationally
Cutting corporate income tax (CIT) rates increases the returns to innovation (as to any
investment). A lower capital gains tax supports venture capital (VC), since VC investors’
returns take that form. Canada’s statutory CIT rate has become one of the lowest in the G7,
whereas it had been the highest only a few years ago. This should stimulate business
innovation in Canada, including by attracting more foreign firms and the technological and
managerial know-how that they often bring.
However, marginal effective tax rates on capital remain uneven. Tax breaks to
manufacturing and natural resources (abstracting from oil and gas royalties) penalise
services, which are a critical emerging area for the knowledge economy. The small business
deduction for Canadian controlled private corporations (CCPCs) provides tax relief to SMEs
that is phased out as a corporation grows in size. Indeed, small firms account for a
substantially larger share of employment in Canada than in the United States. While the
tiny population of innovative start-ups are responsible for a disproportionate amount of

© OECD 2012 20
breakthrough innovations and net job creation, not all small firms are young, and MFP
growth appears to be concentrated at the medium-sized range (ICP, 2012). The reduction in
the general federal CIT rate will serve to reduce the disparity in treatment of large and
small firms, and to that extent should encourage small innovative firms to expand sales,
enter foreign markets and attain the scale needed for successful innovation,
competitiveness and high MFP growth.
Figure 12. Fiscal support and business R&D investment, 2009¹
As a percentage of GDP
0.0
0.1
0.2
0.3
0.4
0.0
0.1
0.2
0.3
0.4
FRA
KOR
SVN
USA
CAN
BEL
IRL
AUT
CZE
DNK

GBR
ISR
SWE
NLD
ESP
NOR
PRT
HUN
AUS
TUR
JPN
ISL
DEU
FIN
EST
CHE
ITA
LUX
NZL
POL
GRC
MEX
SVK
A. Direct goverment funding of business R&D and tax incentives for R&D
Direct government funding of BERD
Indirect government support through R&D tax incentives
0
1
2
3

4
0
1
2
3
4
ISR
FIN
KOR
JPN
SWE
CHE
DNK
USA
DEU
AUT
ISL
FRA
BEL
AUS
LUX
SVN
IRL
GBR
CAN
NOR
CZE
NLD
PRT
ESP

ITA
HUN
EST
NZL
TUR
SVK
POL
MEX
GRC
B. Expenditure on R&D in the business sector (BERD)

1. Or latest available year.
Source
: OECD,
OECD Science, Technology and Industry Scoreboard 2011
.
Innovation support is being rebalanced toward private-sector needs
Support for innovation ranks very high on the list of government priorities, and it has
been appropriately protected from the 2012 budget cuts. The federal government supports
research in Canada mainly via the National Research Council (NRC) and the three granting
councils for the natural, social and health sciences. The 2007 federal science and technology
strategy identified four areas of public research focus (energy, environment, health sciences
and ICT) and called for an expansion of human capital in STEM subjects (science,
technology, engineering and mathematics), backed up by increased funding to public
research in all subsequent budgets. To increase the effectiveness of public research, the
strategy expanded public-private partnerships, notably in the framework of the networks of
centres of excellence. In its recent budget the federal government also refocused the NRC
on business-oriented research. The government has commissioned three major reports
covering areas of: competition policy (Competition Policy Review Panel, 2008); business
innovation strategy (Council of Canadian Academies, 2009); and R&D policy (Independent

Panel on Federal Support to R&D, 2011, also known as the Jenkins panel). Many of the
recommendations put forward by these reports have been or will be appropriately
implemented.


© OECD 2012 21
The main federal R&D support programme is the Scientific Research and Experimental
Development (SR&ED) tax credit, which is supplemented by provincial credits. SR&ED is one
of the most expensive tax expenditures in Canada: CAD 3.6 billion from the federal
government and CAD 1.5 billion from the provinces and territories in 2011. The R&D tax
subsidy rate (which includes programmes other than SR&ED) is among the highest in the
OECD (Figure 12). By contrast, grants are very low.
While this policy mix importantly avoids the need to “pick winners”, it is potentially
poorly targeted. Even though there is preliminary evidence that tax credits stimulate R&D
spending (Lester, 2012), other research suggests that, in the case of level-based credits,
much of that may not be incremental, insofar as large firms doing R&D anyway also apply
for tax relief (Baghana and Mohnen, 2009). Furthermore, the blunt instrument of tax credits
may not always direct resources to areas with the highest social spillovers. These
considerations suggest that innovation might be encouraged more effectively, and risks
better balanced, by reducing the importance of tax expenditures and relying more on
grants.
For small CCPCs, the tax credit is almost double that for large firms. The rate of
subsidisation of small CCPCs can go up to 70% including provincial credits and various
direct grants (IPFSRD, 2011), which may result in a very high marginal effective tax rate on
income when the firm’s income passes CAD 500 000, the level at which the tax credit on its
R&D is reduced. The small CCPC credit is furthermore refundable up to a limit so long as the
firm generates no cash flow. There are substantial fixed compliance costs involved in
qualifying for the credits, however.
The Jenkins panel recommended streamlining the SR&ED, notably for small- and
medium-sized firms, and using the fiscal savings to boost direct grants to the Industrial

Research Assistance Program (IRAP), a large grant programme that provides advice in
addition to funding, mostly to small innovating firms (IPFSRD, 2011). The 2012 budget made
a number of changes to the SR&ED that will be fully effective by 2014. Capital will be
removed from the SR&ED expenditure base for
all
firms. Eligibility for overhead and
contract costs is being progressively tightened and administration will be further simplified.
The regular (large firm) subsidy rate will be reduced from 20% to 15% in line with the
decline in the general CIT rate, while the small firm rate subsidy remains unchanged at
35%. Funding to small and medium-sized businesses through IRAP is being doubled
immediately. The proposed rebalancing of business innovation support needs to be
carefully implemented and evaluated.
The policy rationale for the enhanced refundable credit is to internalise the positive
externalities of R&D performed by CCPCs and to compensate for their constrained access to
finance. However, the generosity of the subsidy could result in the allocation of too many
resources to small firms. The current level of the SR&ED subsidy for large firms appears to
be justified by externalities, net of costs (Parsons and Phillips, 2007). Instead of reducing the
SR&ED rate for large firms, it would have been preferable to reduce the differential by
lowering the small firm rate toward the large-firm level, while maintaining a broad base,
inclusive of capital, to avoid creating distortions in favour of small and/or labour-intensive
firms.
Do financial markets allocate funds to innovation effectively?
A well functioning financial system is important for allocating capital to firms and
sectors, while pricing risk efficiently. VC and private equity segments of the capital market
specialise in innovative start-ups and other high-risk ventures. They rely on close
monitoring to reduce informational asymmetries and on buoyant public equity markets for
lucrative exit opportunities. Canada’s VC market is only about one-third as large relative to
GDP as in the United States, though still higher than in a fair number of other OECD
countries (Figure 13). Institutional investors (such as pension funds) have shied away from
the VC market segment but are sorely needed to provide it with depth. The lack of a single

© OECD 2012 22
securities regulator has been identified as giving rise to high transaction costs, inconsistent
reporting and accountability standards, and patchy enforcement (FSB, 2012; OECD, 2010a).
Greater cross-provincial harmonisation and consistency in securities market regulation
would help to deepen capital markets and improve resource allocation across the country.
Figure 13. Venture capital investment, 2009
Percentage of GDP
0.00
0.02
0.04
0.06
0.08
0.10
0.00
0.02
0.04
0.06
0.08
0.10
POL
HUN
ITA
SVN
LUX
GRC
EST
CZE
ESP

PRT
KOR
DEU
AUT
CAN
NLD
GBR
FRA
DNK
AUS
NOR
BEL
FIN
IRL
CHE
SWE
USA
ISR
0.18
Seed/start-up/other early stage
Other venture capital

Source
: OECD,
OECD Science, Technology and Industry Scoreboard 2011
.
VC investments are encouraged through the income tax system, in large part through
the so-called Labour-Sponsored Venture Capital Corporations (LSVCCs). Indeed, some 50%
of the VC market is publicly funded, compared with less than 5% in the United States.
However, a large portion of this investment is directed to regional development rather than

small firm growth. Canadian enterprises supported by private, as opposed to public, VC
appear to have superior performance in terms of value creation and innovation intensity
overall. More worrying is evidence of crowding out of private projects by public VC
(Brander
et al
., 2008). Such crowding out, particularly by LSVCCs, has diminished the
returns of private VC funds and played a key role in driving pension funds and other
furnishers of capital to private funds to the sidelines (MacIntosh, 2012). Following Ontario’s
lead, federal and provincial tax credits to retail investors in these funds should be phased
out.
Stimulating the VC market will prove a challenge, especially as returns have been fairly
low and the global financial crisis sharply cut investors’ appetite for risk in the
United States as well as Canada. Government could help through co-investment funds in
which private partners make the investment decisions. Following the recommendation of
the Jenkins panel to leverage greater private capital and expertise by means of such
co-funding, the 2012 budget boosted direct funding to the VC market significantly. However,
the risk remains that these funds will remain forever dependent on public support.
Is competition providing the necessary spur to innovation?
Vigorous competition is a key motivator of innovation, as firms are driven to innovate
to stay in business (CCA, 2009; Sharpe, 2010). Competitive behaviour is nurtured by
openness to trade and foreign direct investment internationally and by low barriers to entry
and exit in product and labour markets at home. Conversely, firms that are sheltered from
competitive pressures may earn sufficient rents to survive without innovating, even if that
condemns them to remain small. Canada’s product-market policy settings are largely in
line with OECD best practice. Barriers to entry, as captured by the OECD’s Product Market
Regulation (PMR) indicators, are among the lowest in the OECD (Figure 14, Panel A).


© OECD 2012 23
Employment protection is also moderate, which facilitates firm entry and organisational

innovation (Panel D).
Figure 14. Product and labour market regulation indicators
Index scale of 0-6 from least to most restrictive
0
1
2
3
4
5
6
Canada United States EU21
A. Product market regulation, 2008
Overall indicator
State control
Barriers to entrepreneurship
Barriers to trade and foreign investment
0
1
2
3
4
5
6
Canada United States EU21
B. Barriers to foreign direct investment, 2006
Total
Telecommunications
Air transport
0
1

2
3
4
5
6
Canada United States EU21
C. Sectoral PMR, 2008
Electricity
Professional services
Retail trade
Post
0
1
2
3
4
5
6
Canada United States EU21
D. Strictness of employment protection ¹, 2008
Regular employment

1. The OECD indicators of employment protection are synthetic indicators of the strictness of regulation on
dismissals and the use of temporary contracts.
Source
: Panels A and C: OECD, OECD.stat – Market regulation database; Panel B: Koyama and Golub (2006), “OECD's
FDI regulatory restrictiveness index: revision and extension to more economies”,
OECD Economics Department
Working Paper
, No. 525; Panel D: OECD.stat –

Employment protection database
.
Yet, there are residual impediments to competition. In 2011, the OECD’s
Going for
Growth
(OECD, 2011a) identified Canada’s network sectors and professional services as
offering ample scope for regulatory improvement (Figure 14, Panels B and C). There are
signs that some of these barriers are being recognised and tackled:
• OECD work shows that infrastructure sectors are critical to translating the
benefits of innovation, notably in ICT, into generalised productivity gains, and so
rigidities there may reduce efficiency in all sectors (Conway and Nicoletti, 2007).
The government is, encouragingly, committed to sustaining competition in
telecoms, and foreign-investment restrictions have begun to be eased. New
competitors have emerged in the wireless telephony market. The government
has also implemented the competition policy recommendations of
Compete to
Win
(CPRP, 2008). Competition authority powers of monitoring and enforcement
against cartel-like behaviour and abuses of dominant market positions have been
strengthened, and merger and acquisitions notifications and review procedures
have been streamlined.
• Differences in provincial certification requirements for regulated professions that
prevent their mutual recognition create barriers to the interprovincial mobility of
workers in these occupations. Professional services such as architecture,
engineering, and various other businesses and skilled trades include skills